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Income Tax Appellate Tribunal, “A” BENCH : BANGALORE
Before: SHRI N.V. VASUDEVAN & SHRI B R BASKARAN
O R D E R Per N.V. Vasudevan, Vice President IT(TP)A No.407/Bang/2015 is a Revenue’s appeal while IT(TP)A No.585/Bang/2015 is an appeal by the assessee. Both these appeals are directed against the final order of assessment dated 29.01.2015 passed byt he DCIT, Circle 1(1)(1), Bangalore, under section 143(3) r.w.s. 144C of the IT(TP)A Nos. 407/Bang/2015 and 585/Bang/2015 Page 2 of 16 Income Tax Act, 1961 (hereinafter called ‘the Act’), relating to Assessment Year 2010-11.
The first dispute in the appeal by the Assessee with regard to the Most Appropriate Method (MAM) of determining Arm’s Length Price (ALP) in respect of international transaction of import of finished goods for trading purposes by the Assessee from its Associate Enterprise is taken up as a preliminary issue. A decision of the preliminary issue will render decision on Revenue’s appeal on merits of determination of ALP academic.
The assessee is one of the leading manufacturer of telecommunication connectivity and equipment. The assessee entered into several international transactions during the previous year with its Associated Enterprises (AE). One of the transaction which is the subject matter of this appeal is the international transaction of import of structured cabling systems and accessories for the purpose of trading. The details of the international transactions were as follows:
ADC Communications (Australia) Pty. 5,201,848 Ltd. ADC GmBH 24,627,506 Import of finished goods for trading ADC Communications (UK) Ltd 9,027,895 ADC Communications Hong Kong Ltd 7,951,632 ADC Telecommunications Inc 38,092,535 Total 84,901,416
In its TP study, the assessee adopted Resale Price Method (RPM) as the Most Appropriate Method (MAM) for determining ALP. The IT(TP)A Nos. 407/Bang/2015 and 585/Bang/2015 Page 3 of 16 claim of the assessee in this regard for choosing RPM as the MAM was based on Rule 10B(1)(B) of the Income Tax Rules, 1962 (Rules), OECD Commentaries etc. The same was as follows:
“Rule 10B (1) (b) of the rules describe RPM as follows: -
(i) the price at which property purchased or services obtained by the enterprise from an associated enterprise is resold or are provided to an unrelated enterprise, is identified; (ii) such resale price is reduced by the amount of a normal gross profit margin accruing to the enterprise or to an unrelated enterprise from the purchase and resale of the same or similar property or from obtaining and providing the same or similar services, in a comparable uncontrolled transaction, or a number of such transactions; (iii) the price so arrived at is further reduced by the expenses incurred by the enterprise in connection with the purchase of property or obtaining of services; {iv) the price so arrived at is adjusted to take into account the functional and other differences, including differences in accounting practices, if any, between the international transaction and the comparable uncontrolled transactions, which could materially affect the amount of gross profit margin in the open market; (v) the adjusted price arrived at under sub-clause(iv) is taken to be an arm's length price in respect of the purchase of the property or obtaining of the services by the enterprise from the associated enterprise; The OECD Guidelines define the RPM as follows: "a transfer pricing method based on the price at which a product that has been purchased from an associated enterprise is resold to an independent enterprise. The resale price is reduced by the resale price margin. What is left after subtracting the resale price margin can be regarded, after adjustment for other costs associated with the purchase of the product (e.g. custom duties), as an arm's length price of the IT(TP)A Nos. 407/Bang/2015 and 585/Bang/2015 Page 4 of 16 original transfer of property between the associated enterprises." The Resale Price method is regarded as particularly appropriate for the pricing of product purchased by a company that operates as a distributor, which adds little or no value by physically altering the product or contributing valuable intangibles prior to resale.
The justification given by the Assessee for adopting RPM as the MAM was on the basis that RPM can be applied for a distributor of tangible products and that the Assessee performs functions of a distributor of tangible products. Further it was submitted that RPM can be applied as the gross margin is identifiable for the Assessee and the comparable companies. Hence, RPM would be an appropriate method.” The profit level indicator (PLI) chosen for the purpose of comparison of Assessee’s margin with that of the comparable companies was Return on revenue the Assessee would have earned had it dealt with uncontrolled parties at arm's length. The Assessee chose 6 comparable companies. The Assessee took data relating to the financial year in which the international transaction has been entered into and also the data relating to two prior years. The plea of the Assessee was that such a course is permitted if such data reveals facts which could have an influence on the determination of transfer prices in relation to comparability as per the Proviso to Rule 10B.
IT(TP)A Nos. 407/Bang/2015 and 585/Bang/2015 Page 5 of 16
F F FY Average 2007— Sl. Name of the Company Y Y 08 No.
2009- 2008-09 10 Chloride International 1. Ltd. Prowess NA * 10.61% 10.61% Globus Cororation Ltd. 2. Prowess NA NA NA NA K Dhandapani & Co. 3. Ltd. Prowess NA - 9.17% 4.35% 0.48%** Mobile 4. Telecommunications Prowess NA * 6.41% 6.41% Ltd. Pointred Telecom Pvt. 5. Ltd., Prowess NA NA 16.20% 16.20% Remi Sales and Engg. 6. Ltd., Prowess NA 19.89% 20.24% 19.97% Average NA 9.71% 12.49% 11.51%
It was the plea of the Assessee that the arithmetic mean of Gross profit on Net sales of comparable companies is 11.51%. The financial results of the Assessee in Appendix 6 of the TP Study would indicate that the Assessee’s Gross Profit on Net sales was 18.68% during the year ended March 31, 2010 and therefore the international transaction, was at Arm’s length. The following annexures were given to the TP Study of the Assessee:
Background of Comparable companies- Appendix — 4B The margins of the final comparable companies (Trading) based on the databases —Appendix 5B
IT(TP)A Nos. 407/Bang/2015 and 585/Bang/2015 Page 6 of 16
The net margin analysis of Assessee as Appendix 6. The financial statements of the comparable companies are attached as Appendix 7B. The Assessee also reserved its right to perform adjustment for differences in levels of working capital between the Assessee and the comparables and such other adjustments as may be required.
The TPO to whom the AO referred the question of determination of ALP did not accept the claim of the assessee accepting the RPM as the MAM. The reasons given by the TPO in this regard were that TPO found that the taxpayer has used multiple year data in respect of the comparables selected by it for bench marking the profit margins of the taxpayer in the trading segments. According to the TPO, as per Rule 10B(4) of the Income-tax Rules it is mandatory to use current year data. Further, the TPO was of the view that taxpayer has incurred huge expenses below GP level which not only neutralized the profit of the taxpayer but resulted in a loss at the net margin level. In other words it implied that, the taxpayer has performed functions which no routine trader would perform resulting in high expenses and consequent loss and the functions have not been compensated by the AE. Therefore, the TPO proposed to apply TNMM in the trading segment of the taxpayer, as the most appropriate method, for determining the arm's length price of the international transactions of the taxpayer in the trading segment. The taxpayer was also requested to furnish a set of uncontrolled comparables using financial data for FY: 2009-10 only and also furnish copies of the Annual Reports of the companies for examination.
IT(TP)A Nos. 407/Bang/2015 and 585/Bang/2015 Page 7 of 16
The TPO thereafter adopted TNMM and identified 14 comparable companies with an average arithmetic mean profit margin of 6.79% and determined the ALP as follows:
“10. Determination of Arm's Length Price: 10.1 The Arm's Length Price of the international transactions in the trading segment of the taxpayer, is determined as under, by using the TNMM as the most appropriate method and using the set of 14 uncontrolled comparables selected by the TPO with arithmetic mean margin of 6.79% on Sales as above. 10.2 Arithmetic mean PLI 6.79% on Sales
Operating Revenues Rs. 38,06,68,324/- Arms Length Margin 6.79% of Operating Revenue Total Arms Length Cost (ALP) Rs. 35,48,20,945/- @ 93.21% of Operating Revenue Operating Cost Rs. 41,02,08,847/- Excess being adjustment under Rs. 5,53,87,902/- section 92CA
The above shortfall of Rs. 5,53,87,9021- (Rupees Five Crores, Fifty Three Lakhs, Seven Thousand, Nine Hundred and Two Only) is treated as transfer pricing u/s 92CA of the Income-tax Act. 61.”
Aggrieved, the additions suggested by TPO was incorporated in the draft order of assessment dated 25.03.2014 by the AO. The assessee filed objections to the draft Assessment Order before the Dispute Resolution Panel (DRP). The specific contention of the assessee before the DRP was that RPM is the MAM for determining ALP because the assessee operates
IT(TP)A Nos. 407/Bang/2015 and 585/Bang/2015 Page 8 of 16 as a routine trader of telecommunication equipment, which adds little or no value by physically altering the product or contributing no valuable intangibles prior to resale. Hence the RPM ought to be used as the most appropriate method. The Assessee again relied on OECD guidelines which we have already extracted in the earlier part of this order. The assessee also highlight that the international transaction of the assessee is primarily in connection with trading of telecommunication equipment and therefore testing at gross level would sufficiently justify the arm's length condition of such transactions. In the present case, since RPM is used as the MAM, gross margin (Gross Profit/Total Sales) is used as a PLI. This is because, gross profit margins represent gross compensation, after the cost of sales for specific functions performed (taking into account assets used and risks assumed), product differences are less significant. For example, the facts may indicate that a distribution company performs the same functions (taking into account assets used and risks assumed) and the compensation for performing similar functions is required to be equalized across different activities irrespective of the products. The assessee relied on certain judicial pronouncements of various Benches of ITAT in support of his claim that RPM is the MAM in the case of an assessee performing the function of purchasing and reselling without any value addition.
The DRP, however, did not accept the plea of the assessee and they confirmed the order of the AO on the choice of MAM by observing as follows:
“5.1 The grounds above are related and taken up together. We have considered the issue before us and the arguments of the IT(TP)A Nos. 407/Bang/2015 and 585/Bang/2015 Page 9 of 16 assessee. The TPO has pointed out that the assessee has incurred huge expenses below the GP level which has neutralized the profit and resulted in a loss at the net margin level. Thus it is evident that the assessee has performed functions which no routine trader would perform resulting in high expenses. The assessee has not been compensated for the functions performed by the A.E. In our view the reasons given by the TPO for rejecting the RPM method and adopting TNMM are logical and well founded. Given the fact that certain specific expenses have been incurred the assessee as a reseller and the lack of availability of data for costs incurred for similar functions in the case of the comparables the analysis of net margins presents a more reliable perspective. TPO was justified in adopting the TNMM method, This objection is therefore not accepted.”
The DRP excluded certain comparables selected by the TPO under the TNMM method against which the Revenue has filed appeal before the Tribunal. As far as the appeal for the assessee is concerned, the learned Counsel for the assessee submitted at the time of hearing that he would press only ground No.5 which reads as follows:
“5. The learned AO/DRP erred in confirming the contention of the learned TPO that the Resale Price Method ("RPM") was not the most appropriate method and in considering Transactional Net Margin Method ("TNMM") as most appropriate method for determining the ALP of the Appellant's international transactions in respect of import of traded goods and while doing so erred in: (a) Not appreciating that the Appellant is a trader of goods who buys the products from its AEs and sells to unrelated parties without value addition in terms of further processing; (b) Ignoring the explanation provided by the Appellant in relation to the specific economic circumstances under which the Appellant operated in the relevant assessment year, while determining the arm's length price of the international transactions.
IT(TP)A Nos. 407/Bang/2015 and 585/Bang/2015 Page 10 of 16 (c) Not appreciating that the losses at the net margin level of the Appellant were not due to transfer pricing policy in connection with import of traded goods from AEs; (d) Not giving cognizance to the fact that RPM is to be considered as most appropriate method in case of resellers who do not add substantially to the value of the traded goods in terms of further processing as suggested by the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations laid down by the Organisation for Economic Co-Operation and Development ("OECD Guidelines") and referred for guidance in various rulings of Income Tax Appellate Tribunals ("ITAT"); (e) Not providing an adjustment for the differences in the working capital position of ADC India Communications Limited vis-à-vis that of the comparable companies, for the purposes of determination of the arm's length price.”
We shall first take up for consideration in ground of appeal by the assessee with regard to the question as to whether RPM should have been adopted as MAM.
We have considered the submissions of the learned Counsel of assessee which was a reiteration of the stand taken by the assessee before the TPO and DRP. Learned DR submitted that under RPM the assessee has to furnish all the details with regard to the comparable companies. She pointed out that the assessee did not appear before the TPO to give any information. Learned DR placed reliance on the decision of the ITAT Bangalore Bench in the case of Kohler India Corporation Pvt. Ltd., Vs. DCIT (2016) 67 taxmann.com 200 (Bangalore Trib) wherein it was held that when RPM is adopted as the MAM, it was necessary to have close analysis of the products that are subject matter of trading with the products traded by the comparable companies.
IT(TP)A Nos. 407/Bang/2015 and 585/Bang/2015 Page 11 of 16
We have given a careful consideration to the rival submissions. In the case of Mattel Toys (I) Pvt. Ltd., Vs. DCIT, in order dated 12.06.2013, the Mumbai Bench of the Tribunal had an occasion to examine the correctness of adopting RPM as MAM in the case of assessees who purchase products from AE and resell to unrelated parties. In that case, the Tribunal emphasised the importance of comparing only the gross margin in the following words:
“38. Thus, the RPM method identifies the price at which the product purchased from the A.E. is resold to a unrelated party. Such price is reduced by normal gross profit margin i.e., the gross profit margin accruing in a comparable controlled transaction on resale of same or similar property or services. The RPM is mostly applied in a situation in which the reseller purchases tangible property or obtain services from an A.E. and reseller does not physically alter the tangible goods and services or use any intangible assets to add substantial value to the property or services i.e., resale is made without any value addition having been made. Since in RPM only margins are seen with reference to items purchased and sold or earned by an independent enterprise in comparable uncontrolled transactions vis-a- vis the one in the controlled transactions, therefore, in such a situation, the nature of products has not much relevance though their closer comparable may produce a better result. The focus is more on same or similar nature or properties or services rather than similarity of products. In RPM other attributes of comparabilities than the product itself can produce a reliable measure of arm's length conditions. The main reason is that the product differentiation does not materially effect the gross profit margin as it represents gross compensation after the cost of sales for specific functior performed. The functional attribute is more important while undertaking the comparability analysis under this method. Thus, in our opinion, under the RPM, products similarity is not a vital aspect for carrying out comparability analysis but IT(TP)A Nos. 407/Bang/2015 and 585/Bang/2015 Page 12 of 16 operational comparability is to be seen. Since the gross profit margin is the main criteria while evaluating the transactions in the RPM wherein price is identified at which property or services are resold anc normal gross profit margin is derived at by the enterprise which is deducted from the resale price of such property or service in comparable uncontrolled transactions. The gross profit margin earned by the independent enterprise in comparable uncontrolled transactions is served as a guidance factor. This is also what happens in the case of a distributor wherein the property anc service are purchased from the A.E. and are resold to other independent entities, without any value additions. The gross profit margin earned in such. transactions becomes the determination factor to see the gross compensation after the cost of sales. In the instant case, the assessee is distributor of Mattel toys and gets the finished goods from its A.E. anc resells the same to independent parties without any value addition. In such a situation, RPM can be the best method to evaluate the transactions whether they are at ALP.”
Similarly, in the case of Nokia India Pvt. Ltd., Vs. DCIT in order dated 31.10.2015, the Tribunal dealt with the plea of the Revenue on incurring of expenses which does not effect on the gross margins and observed as follows:
“11. The ld. DR vehemently argued against the application of RPM in the given circumstances as the most appropriate method by contending that the assessee incurred huge advertisement and & 178/Del/2010 CO No.77/Del/2010 marketing expenses. In view of such incurring of expenses, the ld. DR stated that the better course would be to apply TNMM which would consider operating profit. We are unable to accept the contention advanced on behalf of the Revenue. The obvious reason for this is that the incurring of high advertisement and marketing expenses by the assessee vis-a-vis the other comparable companies does not in any manner affect the determination of ALP under the RPM. When we consider gross profit in numerator and net
IT(TP)A Nos. 407/Bang/2015 and 585/Bang/2015 Page 13 of 16 sales in denominator, all the expenses debited to the Profit & loss account automatically stand excluded. It is but natural that only those expenses can have bearing on the gross profit that are debited to the Trading account. As the amount of advertisement and marketing expenses falls 'below the line' and finds its place in the Profit and loss account, the higher or lower spend on it cannot affect the amount of gross profit and the resultant ALP under the RPM. If the assessee has incurred more expenses on advertisement and promotion, which, in the opinion of the ld. DR went on to brand building for an AE, then, the transfer pricing adjustment on account of such AMP expenses was separately called for. Since the TPO has not made any separate adjustment on account of AMP expenses and has given effect to the same under TNMM, we hold that the incurring of such higher advertisement and marketing & 178/Del/2010 CO No.77/Del/2010 spend would not affect the calculation of ALP under the RPM. Ex consequenti, we hold that RPM prima facie appears to be the most appropriate method in the facts and circumstances of the instant case.”
In the light of the aforesaid decisions, we are of the view that the approach of the Revenue authorities in rejecting the RPM as the MAM and the reasons given by them for doing so cannot be sustained. We are therefore of the view that in the given facts and circumstances, it would be appropriate to set aside the order of DRP on the issue of ALP and remand the question of determination of ALP to the TPO/AO for consideration afresh adopting RPM as the MAM. As pointed in the decision cited by learned DR in the case of Kohler India Corporation Pvt. Ltd., (supra), the assessee is directed to furnish all the required information necessary for determination of ALP in the set aside proceedings. In view of the decision and the MAM, we are of the view that the grounds raised by the Revenue in its appeal viz., grounds 1 to 4 on the exclusion of comparable companies by the DRP under the TNMM does not require any adjudication.
IT(TP)A Nos. 407/Bang/2015 and 585/Bang/2015 Page 14 of 16
The other ground which requires to be adjudicated is ground No. 5 in Revenue’s appeal which reads as follows:
5. The DRP erred in directing the AO to delete the addition made u/s 40A(7) by relying on the decision of the Hyderabad tribunal in the case of Capital IQ Information Systems (India) P.Ltd without appreciating the fact that the assessee company had incorporated certain changes for which no approval from the CIT was acquired and the contribution to fund is only a provision not an actual expense under the purview of section 37(1) of the Act
As far as ground No.5 of the Revenue is concerned, the facts are that the assessee contributed a sum of Rs.13,23,232/- towards recognized gratuity fund. Gratuity fund had been approved by the CIT vide approval dated 12.02.1993. The assessee was previously known as Krone Communications Ltd. Since the name of the assessee at the time of assessment had been changed to M/s. ADC India Communications Ltd., the AO took the view that the approval on which the assessee sought to place reliance was not valid and accordingly he disallowed the claim for deduction of the aforesaid sum by relying on the provisions of section 40A(7) of the Act. On objections by the assessee, the DRP deleted the addition made by the AO by following the decision of the ITAT, Hyderabad Bench in the case of Capital IQ Information Systems (India) Pvt. Ltd., Vs. ACIT (2014) taxpub (DT) 0556 (Hyderabad – Trib) wherein it was held that even if the payment is made to an unapproved gratuity fund, the same has to be allowed as a deduction under section 37(1) of the Act. In coming to the aforesaid conclusion, the Tribunal followed the decision of the Bombay High Court in the case of Tisco Vs. ITO 101 ITR 292 (Bombay).
IT(TP)A Nos. 407/Bang/2015 and 585/Bang/2015 Page 15 of 16
Aggrieved by the order of the DRP, the Revenue is in appeal before the Tribunal.
We have heard the submissions of the learned DR who relied on the order of the AO. In our view, in the light of the decisions relied on by the DRP, the addition was rightly deleted. We are also of the view that the approval in the erstwhile name of the assessee will hold good and the action of the AO in this regard cannot be sustained. Accordingly, ground No.5 raised by the Revenue is dismissed.
In the result, appeal by the Revenue is dismissed while the appeal by the assesse is partly allowed for statistical purposes.
Pronounced in the open court on the date mentioned on the caption page.